[Column Series] Reassessing Japan's Long-Term Decarbonized Capacity Auctions (No.2) Supporting Fossil Power Under the Label of “Decarbonization”Where Does a 90% Reduction Without Phase-Out Lead?

in Japanese

(Japanese original published on 18 July 2025)

Will the Long-Term Decarbonized Capacity Auction evolve into a mechanism that supports large-scale renewable energy sources, such as offshore wind, along with the flexibility needed to integrate them? Or will it instead favour high-risk, high-uncertainty fossil fuel technologies - such as carbon capture and storage (CCS), new LNG, or ammonia/hydrogen co-firing - effectively prolonging conventional thermal power without a clear phase-out? There is also a risk it could become a long-term support scheme centered around large-scale power sources like nuclear. The direction of this policy is now under question.

Japan’s 7th Strategic Energy Plan, approved by the Cabinet in February 2025, projects that fossil fuels will supply 30–40% of the country’s electricity (3,100–4,900 TWh) in fiscal year 2040. At the same time, under the national climate plan and emissions reduction targets, the power sector is expected to cut emissions by 81–91% compared to 2013 levels. In other words, Japan has set an unusually ambitious goal by international standards: maintaining a large share of fossil thermal generation while nearly eliminating power sector emissions¹.

This column provides an overview of subsidy schemes in Japan’s power market for fossil power, with a particular focus on how the Long-Term Decarbonized Capacity Auction has played out, and the issues that emerge from its outcomes. It aims to reassess the kind of policy framework needed to achieve power sector decarbonization.

1. The Contradiction Between Emissions Reduction Targets and Support Schemes for Fossil Power

Structure of Support for Fossil Power Through the Capacity Market, Reserve Power Mechanism, and Long-Term Decarbonized Capacity Auctions

The Japanese government has set a target of nearly 90% emissions reduction in the power sector by 2040. Yet it continues to maintain large-scale coal power plants classified as “high efficiency,” even as many countries are phasing out coal entirely. The government’s coal policy calls only for fading out “inefficient” coal plants by 2030. Despite this fade-out goal, various market mechanisms support fossil power under the rationale of ensuring a stable electricity supply (Table 1)².

The problem is that it is unclear how these support measures, designed to maintain fossil capacity for energy security, align with long-term emissions reduction targets.

Table 1: Overview of Fossil Power Support Mechanisms under the Power Market Schemes

In this way, Japan has created multiple overlapping policy layers that provide institutional support for maintaining fossil power under the banner of “securing supply capacity.” The result is a structure in which fossil power is underpinned not by market competitiveness, but by public subsidies, to ensure that it can continue supplying the 30–40% share outlined in the Strategic Energy Plan. Meanwhile, there is no clear explanation for how Japan intends to cut power sector emissions by nearly 90% while preserving such a significant share of fossil generation.

Inefficient Coal Power: Preserved Through Operating Limits Rather Than Retirement

The government has set a target to “fade-out” only “inefficient” coal-fired power by 2030, and utilities have submitted corresponding plans. However, even these inefficient coal plants have been eligible to participate and win bids in the capacity market. Over 70% of all auctioned capacity has come from fossil fuel power plants (Figure 1).

Figure 1: Capacity Market Main Auctions –
Bid Capacity and Share by Generation Type (Total of Rounds 1–5)

In an attempt to align with the official coal fade-out policy, starting in FY2025, the government will impose a new restriction: inefficient coal plants with thermal efficiency below 42% will be limited to an annual capacity factor of 50% or less. This is intended to gradually push them out of the market. However, in practice, this means limiting only the amount of electricity generated (kWh), while keeping the installed capacity (kW) intact — allowing these plants to continue participating in the market. How far this measure will accelerate coal plant retirements remains unclear.

Figure 2: Trend in Auctioned Capacity for Inefficient Coal in the Capacity Market

2. The Long-Term Decarbonized Capacity Auction: Outcomes and Systemic Failures

Lack of Bids from Thermal Power Projects

The Long-Term Decarbonized Capacity Auction, implemented twice in 2023 and 2024, has revealed a critical dysfunction regarding thermal power bids. Preparations are underway for a third round. In the first round, bids for thermal projects—including LNG and retrofits for hydrogen or ammonia co-firing—fell short of the targeted capacity³.

For hydrogen/ammonia co-firing retrofits, a cap of 1000 MW had been set, but only 825 MW was bid. In addition, a proposed 68 MW hydrogen co-firing replacement project failed to secure a contract. In the second round, only 1,315 MW was bid against a target of 2,240 MW for LNG-fired power — a bid rate of just 58.7% — though all bids were awarded. For hydrogen/ammonia co-firing retrofits, awarded capacity was only 95 MW, less than one-tenth of the targeted volume⁴.

Table 2: Bidding Results for Thermal Power Projects in the First and Second Long-Term Decarbonized Capacity Auctions

A Superficial “Decarbonization Roadmap” — In Reality, Support for LNG

Even dedicated LNG power plants can qualify for support under the scheme, provided they submit a “decarbonization roadmap” outlining future plans to introduce hydrogen or ammonia. However, these roadmaps are largely self-declared plans by operators. Most outline decarbonization by 2040—a long-term projection with little immediate impact. Even if operators do not fully implement these plans, contracts are generally maintained unless revisions are rejected “without reasonable justification.”⁵ (Details to follow in the next column.)

Thus, while the scheme is nominally intended to promote “decarbonization,” in practice it is heavily skewed toward supporting new LNG power. The results speak for themselves: the total awarded capacity for hydrogen/ammonia co-firing projects was just 920 MW, while new LNG-only projects accounted for 7,070 MW. This means that although these projects claim to pursue future decarbonization through hydrogen or ammonia, such transitions are currently neither technically nor economically viable. In reality, the scheme is supporting the construction of new LNG power plants that are unlikely to be decarbonized in the near term.

The disconnect between the stated goal of “decarbonization” and the actual support for conventional fossil power highlights a structural contradiction that undermines the integrity of the policy framework.

Expansion of Support and Underlying Issues with the Scheme

Following the disappointing results of the first two rounds, the government is revising the scheme ahead of the third auction. Expected changes include higher ceiling prices for hydrogen, ammonia, and CCS projects, the ability to include variable costs such as fuel and CO₂ capture, and adjustments for inflation and interest rate fluctuations⁶.

However, the fundamental problem remains. The scheme justifies continued emissions from thermal power based on uncertain future technologies and vague promises—that these technologies will eventually reduce emissions. This reliance on theoretical future reductions allows present-day emissions to be legitimized under the banner of “decarbonization.” Rather than moving toward effective emissions reduction, this expansion of support risks taking Japan further off course.

3. Embedding a Phase-Out Strategy for Fossil Power — Toward System Reform

The Long-Term Decarbonized Capacity Auction requires a fundamental shift. It should move from supporting fossil power to promoting decarbonization of the power sector led by renewable energy. For fossil power, the policy focus must pivot to a system that encourages emissions reduction alongside a clearly defined and gradual phase-out.

This requires a pause and full-scale review of the current system. Such a redesign should be based on key questions:

1. What forms of capacity are truly needed?
2. How should emissions be managed, including from existing fossil power?
3. Under what strict conditions, if any, should minimal thermal capacity be supported?

The three policy proposals listed below are intended as a first step. They aim not only to improve transparency and effectiveness under the current framework, but also to lay the groundwork for a more fundamental overhaul, particularly by rethinking the role of thermal power in the energy mix.

Table 3: Proposal for an Emissions-Reduction-Based Support Scheme

Such improvements would provide the essential transparency and accountability needed to manage a phased reduction in emissions from existing thermal plants, including LNG. Ultimately, however, what’s required is to redefine the role of thermal power within the broader energy system, and to rebuild the support scheme based on a clear “decarbonization roadmap” — one that explicitly includes an exit strategy for fossil generation.

Conclusion

Despite its name, the Long-Term Decarbonized Capacity Auction is, in practice, designed to provide long-term public financial support to fossil thermal power — a major source of emissions. The current system carries significant risks. These include over-reliance on speculative technologies and continued preservation of emissions, resulting in a growing disconnect between policy goals and reality on the ground.

A scheme that props up technologies already losing competitiveness in the market undermines fair market design and runs counter to the core objective of accelerating the energy transition. In the long term, this may lead to reduced international competitiveness due to higher electricity costs and increased burden on consumers.

Globally, it is well demonstrated that stable supply is achievable even when variable renewables like solar and wind make up the majority of power generation. This is possible through demand-side flexibility (e.g., demand response), grid reinforcement, and battery storage. Japan does not need to build new fossil thermal plants to expand renewables.

What’s now at stake is a fundamental question of policy design:

What kind of system is truly needed to put renewable energy at the center?
And how can we achieve rapid and comprehensive reductions in emissions from thermal power?

Going forward, it is essential to integrate the redesign of the Long-Term Decarbonized Capacity Auction with a concrete fossil power phase-out strategy. This will build a more effective and coherent decarbonization policy framework for Japan.

 

Column Series: Reassessing Japan’s Long-Term Decarbonized Capacity Auctions

No. 1  Overview: Questioning the Effectiveness of the Long-Term Decarbonized Capacity Auction (18 August 2025)
No.2  Supporting Fossil Power Under the Label of “Decarbonization”: Where Does a 90% Reduction Without Phase-Out Lead? (26 August 2025)